How a Blended Model Can Solve Some Market Failures (Part 2): Gradian finds a way to scale anesthesia machines according to demand

Editor’s note: This is the second of a two-part article about how Gradian Health Systems harnesses a seldom-used business model –foundation-owned social enterprise – to manufacture, sell, distribute and support its anesthesia machine. Part 1 described some of the challenges medical equipment manufacturers face in low-income countries, and why conventional models haven’t worked there. This article is part of the market dynamics initiative on NextBillion Health Care. The ongoing series looks to encourage discussion and understanding around how markets impact health outcomes. Click here to read other articles in the series and here to read an explanation of market dynamics as a concept and practice.

A bit of background is necessary to help illustrate how we use this foundation-owned social enterprise model. In the 1990s, a British anesthesiologist working in Malawi, Dr. Paul Fenton, created the Universal Anaesthesia Machine (UAM) in what was a textbook case of necessity birthing invention: When the electricity cut out or the supply chain failed to provide oxygen canisters on time, the conventional anesthesia machines he used to provide anesthesia wouldn’t work. Without the ability to provide general anesthesia, some surgeries couldn’t be performed and patient care suffered.

The machines Fenton had on hand weren’t designed to function in such an environment. So he built his own anesthesia machine that would function without electricity or compressed oxygen, and the forerunner to the UAM was born.

Later, Fenton partnered with a foundation to refine his design. Market research and clinical feedback confirmed what he and his colleagues intuited: There was and still is an enormous need for a device like the UAM in many low-income countries and resource-constrained hospitals around the world.

With a compelling product on its hands, the foundation had to decide how to get it to hospitals around the world. For a variety of legal and technical reasons (an entire future blog in itself), the foundation chose to begin by spinning off the idea into a separate legal entity, and Gradian Health Systems was created, with the foundation as its sole owner and investor.

Like any organization, we have a limited budget and we use it to maximize the return on investment. But the foundation judges its success based not on how much profit can be generated but on the “extra-financial value” created – known in philanthropic circles as the “social return on investment” (SROI). The more people that have access to safe surgery and anesthesia through the use of the UAM, the higher the SROI.

(The UAM being used in surgery at a hospital in Bahir Dar, Ethiopia, left.)

Early on, we decided that donating UAMs was an inefficient way to produce this SROI; our impact was constrained by the number of machines we could donate based on a yearly budget. Demand exceeded supply.

So we chose to use a model that allows us to scale according to demand: selling machines at their marginal manufacturing and shipping cost. This frees up our philanthropic funding to build out a potential market for the machine and address the post-sale market failures described above.

Like a traditional business, we’re investing in the creation of the market by spending money up front – on marketing, research and development, international quality certification and the like – to drive future sales of the machine. Unlike a traditional business, we don’t expect to recoup that cost; it’s paid for with philanthropic funding so that we can offer the machine at as low a cost as possible – an important factor in hospitals’ buying decisions.

Crucially, the foundation’s investment allows us to address the market’s failure to address the post-sale needs of the customer: robust machine training for clinicians and biomedical technicians; easily accessible, open-source spare parts that can often be procured locally; timely maintenance and repair backed by warranty. Using philanthropic dollars ensures that these critically important components will be high quality and ubiquitous, even if they aren’t profitable.

To be sure, these components are expensive, but they are vital to ensuring the provision of safe surgery and anesthesia and, to our customers, produce the highest and longest-lasting SROI.

The idea of a foundation owning a commercial entity seems to be a novel subset of venture philanthropy that offers any number of exit options: the social enterprise could spin off as a for-profit, a nonprofit, or could stay a long-term investee of the foundation. Ultimately, this decision simply depends on the aims of each organization and the needs of the customer.

Whatever the decision, it’s critical that the foundation and social enterprise commit to one another; it would challenge the sustainability of philanthropic investment to, say, have the foundation simply stop funding at the wrong time.

And this model isn’t right for every situation. Foundations should not waste fixed philanthropic dollars on markets that aren’t failing, and some philanthropic solutions simply can’t rely on a market to offer goods and services. But it can be an effective solution when, as in our case, a market exists but is largely failing to serve the customer.

Foundation-owned social enterprise is a novel philanthropic model that has the potential to help solve market failures in a variety of contexts. It’s so novel, actually, that we don’t know of many other instances of its use; if you know of an organization doing something similar, let us know.

Mike Miesen is a business strategy analyst at Gradian Health Systems, a nonprofit social enterprise that equips low-resource hospitals to deliver anesthesia in any environment.